Organogenesis is first detectable morphologically by the appearance of mesenchymal condensates and focal cellular aggregates, or placodes, in adjacent epithelia. Analysis of recombined tissue primordia has established that organ development is regulated by a series of epithelial-mesenchymal interactions with the source of the inductive signal alternating between epithelium and mesenchyme; however, the identity of the signaling molecules driving this process has yet to be fully defined. We have initiated studies examining the molecular regulation of organogenesis in the developing hair follicle, which is a source of cutaneous stem cells and likely site of origin for most epithelial skin cancers. Since focal expression of Sonic hedgehog (Shh) transcripts in embryonic skin heralds the location of future hair follicles, we focused on assessing the involvement of this molecule in skin appendage development. Although normal-appearing hair germs comprising epidermal placodes with associated mesenchymal condensates were detected in both control and Shh -/- embryos at 15.5 days of embryogenesis, progression through subsequent stages of hair follicle morphogenesis was blocked in mutant embryos. Impairment of cutaneous development appeared to be limited to hair follicles since epidermal morphogenesis and the accumulation of terminal differentiation markers was not inhibited in Shh -/- embryos. Following transplantation of newborn mouse skin onto nude mice, control skin underwent complete morphogenesis to produce mature hair follicles containing hair shafts with associated sebaceous glands. In striking contrast, normal hair follicles did not develop in Shh -/- transplants, but some grafts contained groups of cells that expressed markers for hair follicle differentiation and produced abortive hair shafts, indicating that biochemical differentiation of this organ is not dependent on its normal development in this setting. Our results reveal an essential role for Shh during normal hair follicle morphogenesis, and suggest that its primary function in this organ is to regulate tissue growth and remodeling but not the specification of new cell types. Project initiated 1/97, transferred to University of Michigan 7/97.